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Monday, October 28, 2013

The Long-Term Inflection Point

As most readers know by now, I primarily use Elliott Wave Theory for my market analysis. One of the keys for me is to find waves which triangulate the count to a degree. Certain waves will allow me to rule out some counts, and assign higher probability to other counts via the process of elimination, and from experience. The market hasn't had a triangulation wave at higher degree since all the way back in January. What we've had in recent months is a series of waves which could be interpreted as the market unwinding fourth and fifth waves -- but the pattern could also be interpreted as several other ways.

Let's start with the daily chart of the S&P 500 (SPX) to illustrate. Going back to red ii, we had a clear windup of first and second waves, which is why I was strongly bullish back in January and February. In May, I published a target of 1680-1690, which the market hit just before reversing strongly. And that's where the pattern started to get a bit "weird" -- not weird in the sense of being unheard of, but weird in the sense of being extremely difficult to predict.

When we look at the chart below, we can see the series of whipsaws bulls have endured, and the series of higher lows that bears have endured. The pattern looks like an ending diagonal, which is a series of overlapping waves which gradually contract -- in classic technical analysis, it's called a "bearish rising wedge." Diagonals are not supposed to be obvious or easy (though they can be), they're supposed to chop everyone to pieces. The biggest challenge is that they're not always bearish patterns. If you look at the pattern starting at blue A/i and ending at red i, you can see a similar-looking structure. In fact, a lot of folks thought that was a bearish ending pattern at the time, but it instead turned out to be a series of first and second waves.

The market faces a similar situation now, and there's really nothing in the current chart to say that one outcome is higher probability than the other. I've outlined the bear pattern in red, and loosely outlined the bull pattern in green. As I've been talking about for the past few updates, this appears to be an important inflection point.

Let's take a look at this chart from another angle. Below is the SPX monthly chart -- notice on the monthly, SPX is headbutting the upper line of the long-term trend channel (black), and approaching the upper boundary of the very long-term channel in blue ("approaching" in a relative sense -- still a ways to go). This chart suggests there should be some resistance near current levels.

The second challenging feature of the current market landscape comes courtesy of the fact that SPX has now reached February's "bear" count target of 1750 +/- and is in the territory where it could complete the c-wave of a very long-term expanded flat. This means that the long-term counts have come to a fork in the road: Earlier in the year, both counts pointed upwards, but that's no longer the case.

Near-term, the main significant feature of this chart is the so-far successful back test of the breakout over the rising black trend line. It's hard to be terribly bearish as long as that holds, but there are two things which are less-encouraging for bulls: one is the very choppy, overlapping rally since the back-test; the other is the fact that the rally since (4) has been unable to hold above the blue (2)/(4) trend line. Both of those facts suggest buyers are noncommittal at current prices, and we may see some near-term weakness to bring prices back to a level which looks more appealing. Be aware, though, that this is the type of move where -- perhaps counter-intuitively -- buyers would likely step in again and chase at higher prices if "the they" can form a convincing breakout above 1760.

In conclusion, the long-term charts illustrate the importance of the current inflection point, but there's little in the way of clues as to which side will emerge victorious. At times like this, the tiebreaker generally goes to the established trend -- nevertheless, the charts do suggest there should be some degree of resistance near current price levels. Trade safe.

2 comments:

Morning Pretzel. I agree that we should see some resistance at the current level of the SP500. Right now it's up near the upper Bollinger band (+2sd) along with an RSI that are both suggesting overbought. The amount of margin debt is also at a record high. I'm sure that Benny and the FEDs have helped push this margin higher.

You may find this article by Doug Short interesting as it seems to show that NYSE margin debt can be a very good leading indicator of market direction. http://advisorperspectives.com/dshort/updates/NYSE-Margin-Debt-and-the-SPX.phpNotice how the margin debt drops a few weeks before the market does.

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